THE BASICS OF BUY-AND-HOLD

  THE BASICS OF BUY-AND-HOLD
Buy-and-hold is simply defined as buying a diversified portfolio of
high-quality stocks, and/or a diversified group of mutual funds, and
holding them for the long term—typically defined as 10 to 20 years or
longer. This investing approach is well entrenched in books on investing,
in mutual fund marketing literature, and in the verbiage of financial
advisors, academicians, and financial journalists. As you know, it
is almost impossible to change the conventional wisdom.
According to the Chicago research firm Ibbotson Associates,
based on the S&P 500 Index, from 1926 to 2001, there was a 29 percent
probability that that an investor would lose money in the market
if he were investing for a one-year time frame. However, if he
were to invest for a five-year period, the probability of loss
dropped to 10 percent. For a 10-year period it dropped to 3 percent,
and for a 15-year period there would be no loss whatsoever. Translating these three numbers into actual dollar amounts: A
$1000 investment in stocks over the 76-year period would have
been worth $2,279,000, while a bond investment would have been
worth $51,000, and T-bills would have been worth $17,000.
Remember now, these results apply only if you held for 76 years!
Moreover, if the investor restricted his investments to largecap
stocks for this 76-year period, then he would have realized a
compounded annual return of 10.7 percent, as compared to 5.3 percent
for U.S. Treasury bonds, and 3.8 percent for T-bills.
Thus, the argument for buy-and-hold is that a long-term
investor makes out well, while those in the market for short periods
of time have a higher probability of loss. That is true, but bear
markets can significantly reduce investors’ capital. Therefore
investors need a plan of action to limit those situations and preserve
their capital.
From the market peak in January 2000 to its low on October
9, 2002 the mighty bear market has cost investors a whopping $8
trillion in loss in value. If you were a part of the crowd, then you
stayed fully invested as you were taught to do by the proponents
of the buy-and-hold philosophy, and you suffered your share of
those devastating losses. Unfortunately, many investors still hold
their demolished portfolios and are hoping to recoup their losses.
But from the size of their losses, it seems doubtful they will ever
see their money again. Many of the stocks that were purchased
for $50 a share and upwards are now selling for under $10 a
share.
You would think while investors were getting pummeled during
that bear market that they would have the common sense and the
fortitude to cut loose from buy-and-hold and bail out. But that is not
what a CNN/USAToday/Gallup Poll found in a random poll of 720
investors taken on July 29–31, 2002 (when the market had already
dropped by a substantial percentage for the year).
Overall, according to the survey, 63 percent of the respondents
felt that buy-and-hold was the best strategy for them, 30 percent
felt some other strategy which they did not name was better, and 7
percent had no opinion. As you may recall from the previous chapter,
86 percent of the respondents to the ICI/SIA 2002 survey were
buy-and-holders.